Sunday Morning Musings on an Amazon Prime Price Increase

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I have been putting together some thoughts on the possibility the Amazon.com will raise the price of its Prime membership in order to get a better idea of the whys and the whats. For those who missed it, in the most recent earnings call management spoke of the possibility that they will raise the price of Prime by $20-$40 in order to accomodate for rising fuel and shipping costs.

**One of the biggest drivers to get consumers to shop online is free shipping; video, books and 2-day shipping make up the value proposition with Prime today; Prime is $79 per year, Prime for students is $39/year;

**Recent acquisition of Washington Post could be a potential value-add lever for Prime members;

**Amazon (according to BI) has confirmed at least 20 million Prime members today;

**Because the assumptions for this purpose are that a price increase will only affect regular Prime (not Student) let's just assume 100% are Prime (I don't see any estimates of how many are Student, but I'm thinking it's 2% or so). Because it remains constant it cancels out for this purpose;

**So 20 million members at $79 a pop today equals $1.58 billion in membership fees on an annual basis today;

**If we assume zero attrition with a price increase to $99 this equals $1.98 billion in membership fees on an annual basis;

**But people will drop. How many? Hard to say. Maybe 10%? This would leave them at 18 million members at $99 a pop which equals about $1.782 billion;

**The biggest challenge for raising the cost of Prime is more than likely to be the acquisition of new members. There will of course be drops, but if the price raise is communicated effectively it can minimize those. But this alone will not cut it completely. What's the biggest priority here for Amazon?;

**No question fulfillment and shipping costs are the main driver behind the potential increase. But Bezos' biggest priority is to the customer; this is the whole reason behind Amazon's existence as it strives to be earth's most customer-centric company;

**I have to believe he is at least thinking that "choice" is a key word. A price increase on its own takes away choices in that it doesn't offer the consumer more choices. That could be a big problem;

**So what adds more choices? Well there's certainly at least one way and that's through more price points;

**So what if they raise the price of Prime to $99/year, and then offer another price point at $59?;

**Let's go with the assumption that 10% of members quit Prime due to the price increase. That gives us the 18 million members at $99 a pop which equals about $1.782 billion which is 10% less than the price increase with no attrition but 13% more than no price increase at all;

**Members still get all the same services and hey, who knows? Maybe he tacks on a free sub to the Washington Post. It may not sound like much, but it is a nationally-known paper and it's one more thing that you get as a member. A national news source that is essentially free and easy to leverage. And maybe there's more to leverage;

**A less-expensive price point could give Prime members everything they already get with one major difference (maybe two): Instead of free two-day shipping you just get free shipping without the time component;

**Two-day shipping is more expensive than shipping sans a time component.This lower price point Prime membership is just free shipping along with everything else a $99 sub gets. And this Prime membership is only $59/year. Perhaps this membership also doesn't get the lending library and free sub to the Washington Post. I don't know. Again, it frames up the notion that you do get more with the new higher price point as well. (Upgrade to $99 "Prime Plus" and get guaranteed two-day shipping, access to the lending library and a free annual subscription to the Washington Post.);

**So this new price point maybe picks up some of the drops from the price increase, but better yet is serves as a potential acquisition tool because it's a lower price with a ton of offerings still. Think about it from the video perspective alone: 12 months at $59 means you're getting the video service alone for $4.92/month;

**Let's just say that it brings on another 5 million members over the course of time thanks to a big marketing push. That's another $295 million which adds to the $1.782 billion they get with the new price point and 10% attrition which gives them a total of $2.077 billion in membership revenue to go with 23 million total Prime members;

**More members is the big goal here. Like Costco, Amazon needs volume to operate in the low-margin retail game. And like Netflix, more members means the incremental value of each member becomes more and more valuable as they accomodate for the fixed expenses of the content;

**There will be new acquisitions at the $99 level as well. Who knows how many, but there will also be those who upgrade from the $59 level over time as well;

**This bottom line number of $2.077 billion in membership fees with the new, lower price point is:

31.5% greater than the $1.58 billion in membership fees today with no price increase;

5% greater than the price increase to $99 with no attrition at all;

16% greater than the price increase to $99 with 10% attrition;

**And why $99? Just the simple idea that if they can keep the price under $100 then they can continue to really tout what appears to be an amazing value proposition.

My Foolish bottom line

Is this all even reasonable? It could be. There can be no doubt that people will leave with a price increase. While it seems many would probably stick around, some simply will not. What's a shame is that many would probably bag it without doing the math the see if the numbers even bear it out. I for example know that Amazon could triple the price to $237 annually and we would still pay it because over the course of the year we will pay far more in shipping costs alone. We have integrated Amazon into our home's business model. The video and books are just freebies and have created a lot of goodwill for us. Of course the situation is different for everyone. It's also possible that a lower price point could cause more to defect from the higher price point, so differentiating between the two successfully is crucial.

Could the $59 price point attract 5 million members? I don't think it's unreasonable to think that. Free shipping is very powerful as we know already and the video component can continue to serve as a value-add. Particularly if Amazon is already working on a set-top box and/or smartphone offering. Those could serve as potentially very powerful acquisition tools themselves. Not to mention any kind of data offering that could come with them. And if the rumored Amazon TV box is also for gaming as well as the possible Amazon Live TV, well then you have a whole new set of potential offerings that can serve as added value to the Prime relationship. To be sure they could warrant an even higher price point than a $99 offering or at least serve as differentiators between price points.

The basic point of this exercise though is to examine the potential price increase and what it could mean for consumers and investors. The difference between $59 and $99 is significant enough to make me at least ask if two-day shipping is really enough to warrant a $40 difference in cost. For me it does, but I also fully recognize that it won't for others. So then there needs to be more that separates the two. But I also think that the video offering as part of the $59 offering is pretty darned compelling and could bring in a slew of new members if framed correctly. "For less than $5 per month you get Prime streaming along with free shipping on millions of items everyday."

It does seem that as long as Amazon gives this some deliberate thought and keeps the customer's interests as priority number one (as Bezos always does), it should be able to pull this off rather nicely. Of course this is just my $0.02 as a Prime member and Amazon shareholder; worth what you paid.

Much as I hate to say it, I would be more likely to continue as a Prime member at $99, but not if it included a Washington Post subscription. I throw away enough paper, thank you very much! I want the two-day shipping. The rest is just gravy that I don't really use all that much.

Also, it appears that I have been incredibly lax. I have not been an Apple and Amazon shareholder for a while now. Apparently my stops kicked in some $50 or more ago. When the market moved into free fall today, I checked my portfolios and found lots of cash waiting for a place to settle. I settled them back into Apple, Amazon, and Potbelly.